Reinsurance recoverables dragging p&c industry recovery: E&Y

Questions about the long-term sustainability of p&c industry profitability linger in the wake of an already waning hard market, suggests a new report by Ernst & Young LLP. The “Financial Services Market Overview” notes that rate increases are expected for 2004, but signs of price moderation are creeping in, and there is still debate over whether the industry can resist the temptation of price competition and maintain premium growth apace with claims inflation.
“Price alone cannot return the p&c sector to its fullest profitability,” adds the study’s author, Peter Porrino, global and Americas insurance industry services director for E&Y. “Struggles with reinsurance recoverables, loss reserve deficiencies, and other issues across the commercial lines and reinsurance sectors are clouding the sector’s outlook.”
E&Y expects the commercial lines combined ratio to be 93-95% for 2003. “We expect these levels of profitability to continue in 2004, aided by continued but lower rate increases.” And problem lines persist in the commercial lines sector. Porrino compares the ability of insurers to deal with the homeowners’ segment to its inability to find profitability in medical malpractice. For 2003 the homeowners’ line should produce a return on equity (ROE) of 8%, with companies reporting combined ratios in the 80s. On the other hand, the medical malpractice line is expected post a combined ratio of 120%, and negative ROE of 2.7%, an improvement on 2002, but still unprofitable. Med mal’s problems include the challenging legal environment and its condition as a long-tail exposure, which makes it a challenge to price.
Also hampering the p&c industry’s recovery is the growth in dependence on reinsurance recoverables, and the question on how prepared reinsurers are to meet these obligations. This dependence is worsened by surplus depletion – while recoverables once stood at 36% of surplus, they have now hit 60%.
“Relationships between primary insurers and reinsurers have deteriorated and do not appear to be as important as they once were. Many companies are opting to litigate rather than to settle their claims, and many are threatening to deny a claim in order to negotiate the amount downward,” Porrino explains. “Also, decisions regarding claims and actual payments are being deferred in order to retain the float.”
“The uncertainty over reinsurance has had a tangible impact on the p&c sector, as demonstrated by recent announcements of significant write-offs of reinsurance recoverables or significant exposures,” Porrino notes. Examples include CNA, Travelers and Argonaut, each of whom announced a charge in respect of lowered expectations of reinsurance recovery. the exposure to recoverables is worsened by surplus depletion Given the continued pressure on insurer balance sheets, Porrino expects little merger and acquisition activity, and further company specialization on lines that are producing returns, the flip-side being continued exits from under-performing lines.